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Monday, July 7, 2014

Lower unemployment, higher interest rates?

For the past couple of months, one of the main topics of conversation in the financial press is currently under which conditions the buyback program in the United States should be rolled back, and when the Fed will/should raise interest rates again. The most important aspect regarding this issue has been unemployment.

In the meantime, the official unemployment rate in the United States has decreased to 6.1 percent, according to the BLS (Bureau of Labor Statistics). For the fifth consecutive month about 288,000 jobs were created, the best progression since 2000! However, there's still the issue of low wages. One of the reasons why the Dow closed above a historic 17,000 points is that companies are raking in profits due to fact that there are low wages, and they're collecting profits from (still growing) emerging markets. Of course they're also still taking advantage of next-to-zero interest rates.

But now it seems like the markets are facing a turning point. Until now, healthy unemployment numbers were only good for the stock market. But slowly but surely we've come to a point when a further growing job market is less positive for the stock market. The current market's reaction to the good numbers already points in that direction. Good numbers, an insecure market. From now on the inflation numbers, and the rising wages will be weighing on the markets.

Unique times of low interest rates

The governor of the Bank of England has already indicated that the interest rate is likely to increase sooner than the markets expect. James Bullard of the Fed expressed similar thoughts. Of course, maybe they're only thoughts, but there's a truth to it. I bet we'll hear more of those kind of statements in the future. It's like they're trying to introduce the financial markets to this 'new' concept, that somehow - at some time - there's going to be an end to this unique period of extremely low interest rates.

The Fed is obviously worried about the current scenario, and is searching rapidly for solutions to transition the markets back to a more healthy situation. Already a little test was done by introducing exit fees for bond funds.

Safe investment

By the way, bond funds are holding back about 10 percent cash, to pay to future outgoing investors. Many (private) investors have entered bond funds in the past few years, assuming this was a safe(r) investment. But if the markets are going to turn around, things can become very ugly for them, and those same investors could all of a sudden face significant losses.

Communicating the upcoming interest rate hike will be a tough task in the upcoming months for Janet Yellen and her colleagues, given the fact that a strongly decreasing stock market will seriously agitate the economic recovery.

Quality stocks in your portfolio

For investors, a somewhat conservative investing approach (which involves mainly quality stocks with an attractive dividend) seems to be the best survival strategy in the current economic climate. With bonds, risk is now increasing - and there's still the low return (yield). When you invest in stocks, at least the yield remains somewhat intact.

As long as the economy continues to grow, an interest rate hike does not necessarily have to mean an end to the bull market. What is becoming more and more clear, is that there's going to be a transition phase. Maybe it has already begun. Something similar happened in 1994. The markets were wobbly for a few months and corrected themselves. From 1995 it continued on, with a few corrections here and there, and didn't really stop until 2000.

The bottom line...

The fact remains that though the Dow broke 17,000, the interest rate still remains extremely low. Is the economy really growing? Or is this just another bubble ready to burst? In my opinion, if the economy is truly expanding at a healthy rate, why are the interest rates not increased. It can only mean one thing, the economy isn't really recovering, and once life support is taken away by the Fed, the markets could collapse again. I don't think 17,000 is anything to be optimistic about, more something to be cautious about. If the markets are still stable after the interest rate goes up, then I'll be more confident.

Disclaimer:

All opinions expressed, trade recommendations/advice on this website are solely of John van der Munnik and are not affiliated with any investment firm or any other organization. You should not make an investment only based using this website VDM Trading for your trading needs without seeking help from your own financial advisor.